How 401(k) help can hurt your savings

Auto-enrollment gets workers to save, but can leave them saving too little

Employers’ enthusiasm for automatically signing up their workers in the company 401(k) is growing slowly but steadily, according to new data on about 21,000 workplace plans covering 13 million participants.

That’s both good and bad news for workers.

On the plus side, some of these workers may never have started saving if they weren’t pushed into it. On the down side, they are saving at a substantially lower rate than participants who signed up of their own volition, thanks to the low contribution rate employers commonly use in automatic-enrollment plans.

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Twenty-six percent of companies now use auto-enrollment, up from 17% five years ago and just 2% in 2006, when the law paving the way for such tools was passed. The figure jumps to 52% among the largest companies, according to first-quarter data from Fidelity Investments on the plans managed by the giant financial-services firm.

But the average savings rate for auto-enrolled workers is 5%, compared with an average 8% savings rate among all participants in the plans studied. That’s not surprising, really, given that employers are leery of seemingly taking control of a large percentage of workers’ pay and steering it into the savings plan. Almost three-fourths of companies that use auto-enrollment start their workers at a savings rate of 3% or less.

“The odds are you’ll be defaulted in at a fairly unobtrusive rate—3% being the most common—whereas if you had taken the time to fill out the form, you might have contributed at a higher level, and benefited not only from that, but from a higher match,” said Nevin Adams, co-director of the Center for Research on Retirement Income at the Employee Benefit Research Institute, a nonprofit, nonpartisan organization. Neither Adams nor EBRI were involved in the Fidelity study.

“Almost no one ever seems to go back and raise that default contribution,” he said.

In other words, auto-enrollment both takes advantage of inertia, and succumbs to it. About 84% of savers who are automatically enrolled stay enrolled in their savings plan, rather than opting out. In that respect, auto-enrollment is “turning inertia into an advantage,” said Julia McCarthy, executive vice president of workplace investing at Fidelity Investments.

But, because the employer sets the contribution rate, “There’s a sense for many [employees] that that must be the right answer,” McCarthy said. “Inertia sets in and they stay at 3%.”

That’s not a path to retirement success. “An employee who stays at 3% is going to have a really hard time retiring if that’s their only source of income,” McCarthy said.

Change is going to come?

Some employers are starting to shift to higher automatic-contribution rates. McCarthy said that one Fidelity client, a “very large company with a highly compensated workforce,” wanted to explore ways in which the company 401(k) could provide 100% of pre-retirement income for employees, once they retire.

At the time, the company was automatically enrolling workers at a 6% savings rate, combined with a flat match based on workers’ salary. Fidelity’s analysis found that the plan at that time would replace 37% of workers’ salary, on average.

“It became apparent that 100% was probably ambitious,” McCarthy said. But, she said, “The employer was very clear—they wanted their workers to be able to retire at 60.”

Ultimately, the company decided that a 50% income-replacement rate was reasonable, and earlier this year they bumped their auto-enrollment savings rate to 9%, from 6%, with an automatic increase of 1 percentage point a year, up to 15%. The employees get a match on top of that.

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